Unfortunately, debt is a reality for almost everyone these days.
And we know how stressful it can be when you think there’s no way out of it. It probably feels a lot like going in circles with no end in sight.
But, you are not alone. Lots of Americans are in similar situations to yours. The difference is that you’ve acknowledged the problem, and you’re ready to tackle it!
We’re going to take you through a proven strategy to get out of debt called the Debt Snowball Method. Then, we’ll connect you to a debt snowball calculator so you can create a plan of attack and timeline for your financial freedom.
We’re going to cover:
- How’d You Get In Debt?
- Good Debt vs Bad Debt
- Good Debt
- Bad Debt
- What Is the Debt Snowball Method?
- How the Debt Snowball Method Works
- Why the Debt Snowball Strategy Works
- The Debt Snowball Calculator
- Staying Out Of Debt
How’d You Get In Debt?
There’s a million different ways to end up in debt. In many cases, debt is inevitable, and even necessary.
Very few people earn enough money to pay for everything in cash. So, there are certain things that you’ll never be able to have without going into debt.
Do you dream of owning your own home?
Chances are you won’t be able to pay for a house in cash. So, taking out a loan and going into some debt is a necessary step to accomplish that goal.
This is true for some of the biggest and most important purchases you’ll make, like buying a house or paying for a college education.
You’re taking on debt because you know the payoff will be worth it in the end. But, there are many other reasons why people fall into debt which aren’t as beneficial.
Some common causes of debt:
- Medical problems
- Poor spending habits
- Job loss
- Not creating a budget
- Relying on your credit cards
A lot of these things are out of your control. You can’t predict a medical problem or job loss, but those things will put you considerably behind on your bills.
We can’t spend all of our time worrying about situations that may or may not happen. So, you need to identify and focus on the things that you are in control of.
Let’s look at the different types of debt you have, and where they fall on the spectrum.
Good Debt vs Bad Debt
Every debt you have is going to fall into one of two categories, bad or good debt. Good debts are those which are needed to progress and make smart financial moves. Bad debt is the kind that drains your resources and puts you in a bad spot.
So the first thing you’ll want to do is organize your debt by the type. Consider each bill you have, and place it in either the bad or good debt pile.
Good debt is anything that will grow in value over time. They can be considered investments.
Examples of good debt are:
- Buying a house
- Opening your own business
- Purchasing things that save you time and money
All of the above will provide value and growth going into the future.
For instance, buying a home is an example of good debt. Ideally, the market value of your home is going to go up over time. Whether you rent the space out or sell it, you should be able to make a profit in the end.
The best investments are those with tax deductible interest. These usually come with fixed and low interest rates, which makes it easy for you to calculate when your purchase will be completely paid off.
Bad debt comes from purchases that lose their value over time.
If you can’t afford it, don’t buy it. It’s easy to go overboard and spring for that big purchase when you should have just waited.
Bad debts tend to have high interest rates. The higher the interest rate, the higher the payment. That means you’re going to end up spending more over time.
Common Examples of Bad Debt:
- Credit cards
- Auto loans
- Payday loans
Let’s say you buy a luxurious leather jacket for $400. You do not have the cash on hand, so you put the charge on your credit card.
Fast forward a couple of months, times have gotten tough, and you can’t afford to pay the leather jacket off completely. You can only make the minimum payment on your credit card some months, and it takes you 24 months to pay the jacket off.
By the time you’ve gotten your balance back to $0, the jacket has ended up costing you over $500. At this point, it’s out of style already and you’re looking at some new arrivals.
Here’s the question: Was it worth it?
Was it worth it to use your credit card for a depreciating purchase that ended up costing you more in the long run?
You need to be smart about the financial decisions you’re making and the first step is to separate your debt into the good and bad.
Once you have figured that out, it’s time to take action and start paying it down!
What Is the Debt Snowball Method?
The Debt Snowball Method is a debt reduction strategy where you pay off the debt with the smallest balance first, working your way up to your largest debt.
The Debt Snowball Method does not take into account the interest rates of your accounts, just the outstanding balances.
How the Debt Snowball Method Works
You’ll start paying on the account that has the smallest balance first, while paying the minimum payment on all of your other accounts.
As soon as you finish paying down the first account, you move to the next one, while continuing to pay your monthly minimums.
Here’s an example:
Let’s say that you have four credit cards:
- Balance: $520
- Minimum Payment: $25
- Balance: $1,000
- Minimum Payment: $40
- Balance: $1,200
- Minimum Payment: $50
- Balance: $1,500
- Minimum Payment: $50
You’ve created a budget, and have put aside $400 every month to go towards these debts. Following the Debt Snowball Method, you’re going to start paying off Card A first, because it has the lowest balance.
Remember that you’ll need to keep paying the monthly minimum on your other cards while you’re working to pay down the balance on Card A. You do the math, and it works out to $140 a month.
So, from the $400 that you’ve set aside, $140 of it will go towards the minimum payments on Cards B, C & D.
That leaves you with $260 to put towards Card A every month, until it is paid down.
By following The Debt Snowball Method, you’ll have Card A paid off in 2 months.
High five! You can check Card A off of your list, and move onto Card B.
You still have $400 to work with every month, but now your minimum monthly obligations have decreased to $100. So, you’re able to put $300 towards Card B every month.
That means you’ll have Card B paid off within 4 months.
2 cards crossed off your list! Feels pretty good, right?
Once you finish paying off Card B, you’ll move onto Card C. At this point, you’ll have $350 to put towards Card C and the remaining $50 will go towards maintaining your minimum payment on Card D.
Card C will be paid off within 4 months, and you’ll finally move onto Card D. Now you’ll be able to designate the full $400 towards this last account, which means it’ll be paid off in 4 months as well.
By using The Debt Snowball Method, you’ve eliminated your debt in 14 months.
Doing so will throw you into a vicious debt cycle that becomes difficult to break free of.
Why the Debt Snowball Strategy Works
The Debt Snowball Method works well because of the psychological effects the strategy has on your brain. Paying off a credit card in full feels great! This excitement will give you a push to keep the motivation going, and pay off the next card.
Each little debt that disappears will give you a sense of relief and accomplishment that you can’t even imagine. Once you start seeing results quickly, you’ll get excited and work harder to accomplish your goal.
Plus, you’ll be in a better position to manage your money once you’ve mastered The Debt Snowball Method. You’ll be aware of how much money you have in comparison to your debts, and be able to take control of your finances.
— Get Out of Debt (@getoutofdebtcom) May 3, 2018
The Debt Snowball Calculator
Staying Out Of Debt
Keep a close eye on your financial situation and don’t get carried away making unnecessary purchases.
When you do find yourself in debt, it’s important to tackle the problem with a surefire strategy.
The Debt Snowball Method is a great plan of attack to bring those credit card balances back down to $0. Use a Debt Snowball Calculator to have a concrete timeline of when your debts will be paid off.
You’ll start to feel the relief right away!
Have you used a Debt Snowball Calculator before? Let us know in the comments!